A JOURNEY BACK five years to Euromoney’s 2002 foreign exchange poll (May 2002) shows that we identified a dominant theme of market consolidation then. We suggested that the market appeared set for domination by just five banks – much as today – and that consolidation was supposedly going to lead to a reduction in the number of trading venues, possibly to the extent that activity would become concentrated on just one. We wrote: "There’s no doubt that barriers to entry are rising in forex. To be a top-10 player in the market requires not only expertise and global presence but also good technology."
Five years on it’s apparent that our judgement was both true and false. Technology and a global presence do play a key role in maintaining a position in the top 10. But technology has also allowed the entry of new players to the market – specifically those established to service the increasingly important retail sector – often on a virtual global basis. It has also attracted participants from other asset classes, not all of which are welcome, that have found it easy to access an efficient, transparent and extremely liquid market. The result is a market that has boomed, particularly in terms of volume – paradoxically, perhaps, at a time when volatility has seemingly been on a never-ending downward path.
Five years ago few would have predicted the increase in volumes. Back then, FX was emerging from a period when not too many outside the industry defined it as an asset class. To many, it was a mere sideshow, something bolted on to cross-border trades in other instruments, such as bonds and equities. Merger activity had removed several active participants from the market, and structural changes, such as the creation of the euro, had resulted in a severe decline in volumes. According to the Bank for International Settlements, average daily spot volume fell by almost a third between April 1998 and 2001.
A year later, there was more optimism. It seems that much of this was based on the early success of e-commerce. What was not anticipated was just how much this would facilitate market entry to previously untapped and unserviced sectors and the impact this ease of access would have, even if there did seem to be some tacit awareness that something was about to happen.
"We’ve achieved great strides towards offering clients a more holistic approach to foreign exchange, and they’ve rewarded us with a greater share of their business," said Jim Turley, Deutsche Bank’s global head of FX at the time. "If we can achieve what we think we can, we’ll be in uncharted territory," he predicted.
Fabian Shey, who is now global head of FX distribution at UBS, showed similar prescience. "We’re building a strategy about how to bring services to client types at the right price," he said. "We need to know how to price and brand appropriately, and how to meet the demand of each client segment."
At various stages over the past five years, the sell-side liquidity providers have struggled to do this and this has created tensions. Now, though, it appears they are once again largely on top of the situation. Moreover, the idea of market segments is now an accepted concept. So the market has not consolidated. It has remained segmented. Fragmentation often implied market inefficiency. Segmentation suggests that the market is sufficiently mature and liquid, and sufficiently technologically advanced, to cater for the vastly different needs of its many participants.
As a result, it can no longer be taken as a given that there will be a reduction in trading platforms and venues, even if many are still predicting it this year following State Street’s acquisition of Currenex. Just five years ago, the collapse of Atriax – despite its big backers – was widely believed to herald the same thing.
So looking ahead, how will the FX market develop in the next five years? Obviously, nobody can really be sure. "Five years is right in the middle between somewhat predictable and totally unpredictable, as defined by Bill Gates’ famous saying. And I think we are too far down the axis to really be able to make a qualified prediction," cautions Saxo Bank’s chief executive, Lars Seier Christensen.
Despite that judgement, there are obvious questions that participants from across the spectrum want to see answered, including:
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• Will volume growth continue at the same rate?
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• Will the retail sector become an increasingly important area?
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• Will there be an increase in regulation, especially if the retail sector continues to expand and in the post-Mifid environment?
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• Can FX be successfully delivered as a single-asset solution, or is multi-asset the way forward?
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• With the reported growth in programme and algorithmic trading, is there still room for the human trader?
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• Will there be a reduction in trading venues?
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• Is there a need for a central counterparty (CCP) in FX?
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• Will options ever really trade electronically?
Volume growth still predicted
It seems that most industry participants are in agreement that volumes will continue to expand, although perhaps not at the same rate as in the past. "The infrastructure drive across the industry is geared towards sustained and growing volumes, so, yes, we expect volumes to continue to increase, both as FX is increasingly recognized as an asset class in its own right and as volumes continue to consolidate into the top tier," says Ivan Ritossa, global head of FX and head of Asian trading at Barclays Capital.
Richard Leighton, global head of FX at Standard Chartered, agrees that volumes will keep on rising, driven by a wide variety of sources. "We certainly expect volumes to continue to grow in the next few years albeit at a slightly slower pace," he says. "The combination of continued significant growth in global trade flows with new trade corridors developing between Asia and Africa, for example, combined with deregulation trends in the emerging power economies in Asia and the growth of institutional investor flows in the Gulf will result in significant growth in retail, institutional and corporate FX flows, not only in G10 currencies but increasingly in the currencies of Asia and the Gulf in particular."